The Snowball

by Alice Schroeder

  Still, for the first time, Buffett and Munger had found something they could partner on. Through Diversified Retailing, they and Gottesman had, in effect, created a separate company specifically to own retailers. But Hochschild-Kohn was the beginning of a pattern that would recur more than once in frothy markets: Buffett had lowered his standards to justify an investment. That he had done it at a time when he was having more and more trouble finding what he considered to be good investments in the stock market was no coincidence.

  In this case, “We were enough influenced by the Graham ethos,” says Munger, “that we thought if you just got enough assets for your dollars, somehow you could make it work out. And we didn’t weigh heavily enough the intense competition between four different department stores in Baltimore at a time when department stores no longer had an automatic edge.”

  Within the first couple of years at Hochschild-Kohn, Buffett had figured out that the essential skill in retailing was merchandising, not finance. He and his partners also had learned enough about retailing to understand that it was a lot like the restaurant business: a wearying marathon in which, every mile, fresh, aggressive competition could leap in and race ahead of you. When the three had the opportunity to acquire another retailer through DRC—this one very different and run by a true merchandiser—they went ahead, however. This retailer came to them through Will Felstiner, the lawyer who had also worked on the Hochschild-Kohn deal, who called to say, “If you’re interested in retailing, here’s the numbers on Associated Cotton Shops.” The Cotton Shops sold women’s dresses. Here Buffett was headed even further afield from his basic “circle of competence,” although this next episode would bring into his fold one of the all-time greatest managers and characters he would ever meet in his life.

  “A cheap little scroungey” is how Munger described Associated Retail Stores, the parent of the Cotton Shops.14 Seeing a set of third-class stores for a fourth-class price, he and Buffett were immediately interested. Associated owned eighty stores with $44 million of sales and earned a couple of million dollars a year. Benjamin Rosner, its sixty-three-year-old proprietor, ran discount dress shops, in tough neighborhoods in cities such as Chicago, Buffalo, New York, and Gary, Indiana, under names like Fashion Outlet, Gaytime, and York. Sometimes he installed several tiny stores carrying the same goods under different names on the same city block. They ranged in size from that of a modest New York City apartment to a well-appointed suburban house. Rosner kept the overhead microscopic and sold only for cash. Running these outlets required unusual skills. In Chicago, a manager at the Milwaukee Avenue store, a big, hard-boiled woman, “blew a whistle every time she saw somebody come in that she knew was a shoplifter type. All the employees would look over and watch the guy from then on. She knew them all and had the lowest ‘shrinkage’ rate of practically any store you could ever find in the toughest neighborhood you could imagine.”*23

  Born in 1904 to Austro-Hungarian immigrants, Ben Rosner dropped out of school in the fourth grade. In 1931, the downdraft of the Great Depression, he started with one little store on the North Side of Chicago, $3,200 in capital, a partner, Leo Simon, and a batch of dresses they sold for $2.88 apiece.15 When Simon died in the mid-1960s, more than three decades later, Rosner continued to pay his widow, Aye Simon†24 (daughter of communications mogul Moses Annenberg), Leo’s salary in exchange for the nominal task of signing the rent checks for their eighty stores.

  “This went on for about six months, and then she started complaining and second-guessing and criticizing. And that really got to Ben. She was a spoiled, spoiled, spoiled woman. Now, Ben was a guy whose principle, as he later explained to me, was to screw everybody except his partner. And in his mind, she’s no longer his partner. So he decided that he had to end this whole thing.

  “So as the switch flips in his mind, he’s going to screw her. He decided that he was going to sell the business to me too cheap, even though he owns half of it, because it’ll show her. When we met with him, he started talking and I got the picture very quickly.”

  Buffett had been there before with people who were talking themselves into thinking they were better off without something, and he knew not to do anything that would interfere. “He’s talking about selling his business that he’s built up all his life, and he’s going crazy because he can’t stand it and he can’t stand her. He’s just a total mess. So Charlie goes back in the room with me. And after about half an hour, Ben was jumping up and down, and he said, ‘They told me you were the fastest gun in the West! Draw!’ And I said, ‘I’ll draw on you before I leave this afternoon.’”

  Buffett needed a manager, but Rosner told him that he would stay only until the end of the year, then turn the business over to the new owners. Buffett could see, however, that, just as the business couldn’t carry on without Rosner, fortunately, Rosner couldn’t carry on without the business.

  “He loved it too much to quit. He kept a duplicate set of store records in the bathroom so that he could look at them while he was sitting on the can. He had this rival, Milton Petrie of Petrie Stores. One time, Ben went to a big bash at the Waldorf. Milton’s there. They immediately started talking business. Ben said, ‘How much do you pay for lightbulbs? How much do you mark up…?’ And that’s all Ben could talk about. Finally, he said to Milton, ‘How much are you paying for toilet paper?’ And Milton said so much. Ben was buying his quite a bit cheaper, and he knew that you want to be not just cheaper but right. Milton said, ‘Yeah, that’s the best I can get.’ And Ben said, ‘Excuse me,’ and he got up, left the black-tie benefit, drove out to his warehouse in Long Island, and started tearing open cartons of toilet paper and counting the sheets, because he was suspicious. He knew that Milton could not be paying too much by that wide a margin, and therefore that he must be getting screwed himself somehow on toilet paper.

  “And, sure enough, the vendors were saying there were five hundred sheets per roll in one of these things. And there weren’t. He was getting screwed on toilet paper.”

  Buffett knew that he wanted to be in business with the kind of guy who would leave a black-tie party to count sheets of toilet paper; a guy who might screw the guy across the table but never his own partner. He made a deal with Rosner for $6 million. To make sure that Rosner would stay on the job after he bought the business, he flattered Rosner, made certain he got the numbers to evaluate its performance, and otherwise left him alone.16

  Buffett felt at one with the Ben Rosners of the world—he saw in their relentlessness the spirit of success. He was sick of problem companies like Hochschild-Kohn and was looking for more Ben Rosners, people who had built excellent businesses that he could buy. He and Rosner shared a mutual obsession. As Buffett liked to put it, “Intensity is the price of excellence.”

  30

  Jet Jack

  Omaha • 1967

  As late as 1967, Susie seemed to think that Warren would be more attentive to her and the family if he quit working. In her mind, the two of them had an understanding that they would scale back their lives once he made $8 or $10 million. His 1966 fees of $1.5 million and gains on his capital brought the family’s net worth to over $9 million.1 She badgered him that the time had come. But Warren’s pace never slackened as he shifted his focus from one preoccupation to another: raising money for the partnerships, buying National American, Sanborn Map, Dempster, Berkshire Hathaway, Hochschild-Kohn, American Express, and any number of investments in between. Sometimes his back seized up when he got on a plane, and occasionally Susie had to nurse him for several days while he was bedridden with pain. His doctor couldn’t find any specific cause, suggesting that work or stress might have something to do with it. But Warren was about as likely to stop working for the sake of his back as he was to fork down a big plate of broccoli for the sake of his health.

  He was always sitting hunched over something, a book, the phone, a bridge or poker game with friends like Dick Holland and Nick Newman, a prominent businessman who owned Hinky Dinky, the sam
e grocery chain from which Warren had slunk, humiliated, as a boy after his grandfather sent him to buy loaves of bread. Newman and his wife were active in the community and in civil-rights circles, and, like the low-key Hollands, they were typical of the Buffetts’ friends. Warren and Susie stayed away from the Omaha social circuit. Their joint social life was evolving into a series of recurring events that followed the rhythm of Warren’s work and often took place when they were traveling to see Warren’s friends. In town, however, Susie stayed on call; she shuttled between her own friends, family, needy cases, and community work. A sign now hung on the Buffetts’ unlocked back door that read: “The Doctor Is In.” One or another of Susie’s “patients” could often be found wandering around the house. Her clientele came from all different ages and stations in life, and some were more demanding than others. They asked and Susie gave, and when they asked for more, she gave more.

  When Susie asked, Warren gave, and when Susie asked for more, Warren complied. Unyielding about how he spent his time, he gave in to her on almost everything else. This was the year they remodeled the house. Already the biggest on the block, under Susie’s direction a new wing replaced the old garage, giving the neighborhood kids a place to gather in a new family room. Warren was excited at having his own racquetball court in the basement underneath—like Ping-Pong on a human-size scale—where he took his friends and business colleagues to play.

  But even though Warren was like a kid in many ways, and Susie wished he were a more attentive father, he was loyal and committed: He showed up at school events and took the children on vacations. And while 1967, the year of White Rabbit and Sgt. Pepper’s Lonely Hearts Club Band, marked the apex of the rock-and-roll drug culture, with Susie Jr. in eighth grade, Howie in sixth, and Peter in third, the Buffetts were blessedly free of worries faced by many other parents.

  Susie Jr. had developed from a timid child to a self-sufficient teen and the undisputed boss of her siblings. While her mother filled the house with ballads and soul music when she sang and played albums, Little Sooz had turned into a rock-and-roll girl; she introduced her brothers to groups like the Byrds and the Kinks. She was a straight kid, however, not sucked into the druggy element at school. Howie, now twelve, was still young enough to try to scare his sister and her friends by looming from the crabapple tree outside her window in a gorilla costume. But his pranks were getting more sophisticated, and more dangerous. He put Scout the dog on the roof, went downstairs, and called him to see if he would come. Scout did, and wound up at the vet with a broken leg. “Well, I just wanted to see if he would come,” Howie protested.2 To foil his mother from periodically locking him in his room out of frustration, he bought a lock at a hardware store and started locking her out. Peter spent hours at the piano, playing by himself or with his friend Lars Erickson. He was winning talent shows and seemed as absorbed in his music as his father was in making money.

  The one person in the family who was seduced by the dark side of the psychedelic sixties was seventeen-year-old Billy Rogers, son of Susie’s sister, Dottie, now a budding jazz guitarist who was experimenting with drugs. His mother did some volunteer work and was an expert seamstress, but she also slept until noon, seemed paralyzed by making decisions, and at times was so distant and vague that it was literally impossible to carry on a coherent conversation with her. Dottie was drinking more and not paying attention to her kids. Susie often took Billy to watch Calvin Keys, a local jazz guitar player—so that Billy could learn technique from him, but also to try to straighten Billy out.3

  She faced a daunting task in an era when the drug culture of pot and LSD was ubiquitous and Timothy Leary invited America to “Turn on, tune in, drop out.” The youth-led counterculture was rebelling against all forms of authority, everything for which the prior decades had stood. “This ain’t Eisenhower’s America no more,” said one of the hundred thousand hippies milling about San Francisco’s Haight-Ashbury that summer, as if that were explanation enough.4

  Warren still lived in Eisenhower’s America. He had never suffered from Beatlemania. He wasn’t singing “Kumbaya” or putting up posters saying that war was unhealthy for children and other living things. His state of consciousness remained unaltered. His mind was deep in rigorous philosophical inquiry, torn between the cigar-butt philosophy of Ben Graham and the “great businesses” of Phil Fisher and Charlie Munger.

  “I was in this Charlie Munger–influenced type transition—sort of back and forth. It was kind of like during the Protestant Reformation. And I would listen to Martin Luther one day and the Pope the next. Ben Graham, of course, being the Pope.”

  While Munger was nailing his theses on the door of the Cigar Butt Cathedral, the market itself had abandoned all authorities past and present; as the 1960s progressed, chatter about stocks enlivened cocktail parties, and housewives called their brokers from the beauty parlor. Trading volumes were up by one-third.5 Buffett, at thirty-six, felt like a grizzled old man in a world that craved Transitron, Polaroid, Xerox, Electronic Data Systems—companies whose technology he did not understand. He told his partners that he was slowing down. “We simply don’t have that many good ideas,” he wrote.6

  Yet he did not relax his rules in search of ways to keep the money at work. Instead, he laid out two new restrictions that would make it even harder for him to invest. These personal preferences now became part of the official canon.

  1. We will not go into businesses where technology which is way over my head is crucial to the investment decision. I know about as much about semiconductors or integrated circuits as I do of the mating habits of the chrzaszcz.

  2. [W]e will not seek out activity in investment operations, even if offering splendid profit expectations, where major human problems appear to have a substantial chance of developing.

  By “major human problems” he meant layoffs, plant closings—and union businesses that couldn’t take a strike. This also meant he would think once, twice, three times, before smoking any more cigar butts.

  The cigar butts he owned were problem enough. Berkshire Hathaway was now “on life support.” Buffett had recently hired his Peat, Marwick auditor, Verne McKenzie, and sent him off to New Bedford to oversee the wretched textile mill. He had been regretting a mistake he had made at a recent Berkshire Hathaway board meeting. Feeling flush during what would turn out to be a brief moment of financial success—“we were selling out of rayon linings for a few months and making a lot of money”7—Buffett had let himself get talked into a ten-cent-per-share dividend. The firm’s lawyers had argued that Berkshire was doing so well that it might be accused of unjustifiably retaining earnings. Either while daydreaming or simply in a moment of weakness, Buffett went along with the distribution; a dime a share sounded measly; it somehow took him twenty-four hours to realize the fallacy of their argument. By then it was too late and his uncharacteristic agreeableness had showered on the partners and shareholders $101,733 that he knew he could have turned into millions someday.8 He would never make a mistake like that again.

  Eight months later, Buffett offered the Berkshire shareholders a swap. Anyone who wanted an income-producing security could have a 7½ percent debenture in exchange for stock. A total of 32,000 shares were turned in. With this move Buffett washed out of the mix a group of shareholders who wanted income, ensuring that the rest were more likely to care about growth instead of dividends. “It was brilliant,” says Verne McKenzie.9 And, of course, with fewer shares outstanding, he was able to tighten his grip on Berkshire that much more—curiously, even as the magnitude of his original error in buying the place was clearer. Ken Chace stoically followed Buffett’s orders to shrink the business. Rather than precipitate a hateful backlash like that at Dempster, Buffett listened to Chace’s recommendations that the unions be treated well, and decided to tolerate losses to keep some remnant of the company operational and New Bedford content.

  By 1967 Chace and McKenzie had managed to pull the hapless maker of men’s suit linings back to breake
ven. But the term “inflation”—moribund since the Second World War—was again on everyone’s lips. The costs of wages and raw materials were rising like silt in a river, and both foreign and southern textile mills with cheaper labor were drying up Berkshire’s sales.

  Buffett gave the news to his partners: “B-H is experiencing and faces real difficulties in the textile business. While I don’t presently foresee any loss in underlying values, I similarly see no prospect of a good return on the assets employed in the textile business. Therefore, this segment of our portfolio will be a substantial drag on our relative performance…if the Dow continues to advance.”10

  He tried to pull money out of the textile business as fast as possible. He became intimately involved in the most ordinary decisions of the mills, on the phone almost daily with Chace and McKenzie.11 Chace had had to shut down the Box Loom division for a week back in October 1966 because of competition from imports; less than six months later Buffett told him to permanently shut down the King Philip D division in Rhode Island, which made fine lawn cotton, about one-tenth of Berkshire’s output. The loss of 450 jobs marked the end of Rhode Island’s cotton industry.12 “The tide continues to be far more important than the swimmers” was the bottom line, as Buffett saw it.13

  It wasn’t enough. As the numbers came in, Buffett realized that the Apparel Fabrics and Box Loom divisions were losing so much money that the only way to salvage them was to modernize the equipment. But throwing good money after bad had been Seabury Stanton’s mistake. Buffett refused to invest in the business; it would be like trying to irrigate the desert with a garden hose. Still, closing the plants down would throw hundreds of people out of work. He sat behind his desk and swiveled his chair and thought about it, then thought about it some more.